Emerging markets sovereign and corporate defaults have been among their highest on record this year, and market pricing suggests more are on the way even after a rebound in credit conditions. However, we monitor sovereign liquidity and balance sheets closely, and believe that, with a mix of multilateral support and domestic adjustments, most high yielding names should be able to navigate current challenges. On the corporate side, defaults are concentrated in China property and Russia/Ukraine. Stresses in the rest of the corporate universe are relatively low, supported by healthy leverage level overall.
Emerging Markets Sovereign Default Outlook
We expect the 2022 sovereign default rate to reach 7.5% for the JP Morgan EMBI Global Diversified Index—its highest level since the outset of the coronavirus pandemic in 2020 and second highest in history. This has been driven primarily by Russia (2.9% of the index in notional value terms at the start of the year), Ukraine (2.5%) and Sri Lanka (1.5%). Belarus (0.5%) is also in default and Ethiopia (0.1%), which is dealing with violent social conflict, is expected to be so. Ghana has announced that it will pursue debt profiling for its local currency debt.
Figure 1: Default Rates (% of Notional)
Source: JPMorgan, Neuberger Berman estimates. 2022 values are forecast. As of July 27, 2022.
Among unresolved defaults from previous years, we expect a restructuring agreement this year in Zambia while the process is expected to drag into the future in Lebanon and Venezuela.
The theme is unlikely to go away any time soon. At current prices, bonds from various high-yield-rated emerging market countries including Argentina, El Salvador, Ghana and Ecuador are trading below 50%.
A 2021 study by Moody’s found that the recovery rate on defaulted sovereign bonds averaged 53% over 1983 – 2020 , based on the average 30-day post-default trading price1. Haircuts have varied considerably in recent years, from 22% in Ukraine in 2015, based on JP Morgan estimates, to 43% – 45% in Ecuador and Argentina, in 2020.
The primary market froze not only for the high yield and frontier market names but for the entire market in June and July, as strong outflows from the asset class led to indiscriminate selling. With market access still constrained, sovereign issuers will likely have to rely instead on domestic resources and multilateral funding.
Looking at international reserves versus short-term external liabilities, it is clear that International Monetary Fund support will be crucial for Argentina, Ecuador, Egypt, Ghana, Pakistan, Sri Lanka and Tunisia to manage financing needs (see Figure 2). Should IMF talks lag beyond this year we would anticipate Ghana and Tunisia as default candidates, although the former is prioritizing local currency debt, where the maturity profile and costs are worse, and for the latter the bulk of liabilities are with the official sector.
Figure 2: Reserve Adequacy (% of GDP,2022-2023)
Source: Neuberger Berman forecasts for the average of 2022 – 2023 figures, as of July 13 2022. Top-15 non-investment grade sovereign issuers in benchmark weight, as of June 30, 2022. Reserve adequacy is defined as reserves excluding gold minus the current account and short-term debt. Azerbaijan has been rescaled down to improve visibility.
The interest burden is also quite high (over 30% of revenues) for Costa Rica, Egypt, Ghana, Nigeria and Pakistan, yet it is worth noting that Sri Lanka—the only issuer to plunge into default this year with purely financial reasons—is in a league of its own (see Figure 3).
Figure 3: Public Debt Metrics (2022-2023 Average)
Source: Neuberger Berman forecasts for average of 2022 - 2023 figures, as of July 13, 2022. AO: Angola, BH: Bahrain, BR: Brazil, CR: Costa Rica, DO: Dominican Republic, EG: Egypt, GA: Gabon, GH: Ghana, JO: Jordan, KE: Kenya, LK: Sri Lanka, NG: Nigeria, PK: Pakistan, SV: El Salvador, TR: Turkey, UZ: Uzbekistan.
On the plus side, the sovereign issuer universe is very diverse; oil and commodity producers such as Azerbaijan, Angola and Oman are generally well positioned to cope with the market stress, even in the case of softer oil prices. Furthermore, emerging market sovereign bond prices have adjusted already meaningfully, with most CCC rated countries essentially priced for default and single-B rated bonds trading near 800 basis points on average, versus a long-term average of 600 basis points.
Emerging Market Corporates Default Outlook
We expect a historically high default rate for emerging market corporates in 2022. As a percentage of the total high-yield-rated emerging market corporates universe, which represents 37% of the CEMBI index, we expect a default rate of 16.3% this year. Looking beyond this high headline rate, we note that the bulk of the defaults are in the China property space, as well as among corporates in Russia and Ukraine. Excluding those specific areas, however, we expect the emerging markets high yield corporate default rate to be contained at 2.5% in 2022, as companies have entered this downturn with generally robust balance sheets.
Figure 4: Defaults Forecast
| FY 2022 | 2022 Default Rate YTD (as of Sep 8, 2022) |
NB FY2022 Default Estimate (Midyear revised) |
|---|---|---|
| Asia | 12.4% | 17.1% |
| CEEMEA | 11.3% | 27.4% |
| LatAm | 2.1% | 2.5% |
| Total EM | 9.3% | 16.3% |
| EM ex-Russia, Ukraine, China property | 1.0% | 2.5% |
Source: Neuberger Berman, as of September 8, 2022.
Figure 5: Historical Emerging Markets Corporate Default Rate
% of High Yield Corporates (Ex-Quasi Debt)
Source: BofA, JPMorgan. Neuberger Berman estimates. As of September 8, 2022.
The Asia default rate is estimated to set another record year at 17.1% in 2022, after the regional default rate hit 13.2% in 2021, with stress concentrated in the China property sector (currently with 68% of the sector trading at a cash price below 50 cents). While recent policy support has been extended to select stalled projects and top-quality issuers, the magnitude of these countercyclical measures appears far from adequate to jump-start sector lending and physical housing market activities. Incremental funding for privately owned developers will likely only be available to a handful of top-quality developers for the rest of 2022, and liquidity of many other developers will remain strained. With ”for living, not for speculation" staying as the overarching property policy theme, any upcoming sector support measures are expected to remain piecemeal. Our base case is that there is no “U-turn” in policy but a mild recovery for the sector, with overall confidence remaining low. As a result, our property analyst expects approximately 50% of China property high yield USD bonds to default or conduct distressed exchanges for full-year 2022, based on bottom-up assessments. (Year-to-date through September 8th, 38.6% have already defaulted.)
Stripping out China property from the Asia default calculation, we expect a benign default rate of 2.2% for the rest of the Asia universe (0.7% year-to-date through September 8, 2022). The knock-on effect from the property sector to regional value chains appears contained. Infrastructure spending in China and pandemic recovery away from North Asia support demand and cash flow recovery of regional credits. However, China covid-zero policy will squeeze the weaker issuers in the consumer and transport sector. In addition, we have also identified potential credit issues in several consumer and coal mining credits in South and Southeast Asia, but overall non-China property risk remain low.
In the Central and Eastern Europe, Middle East and Africa region, we expect an elevated default rate of 27.4% for 2022, driven by Russian and Ukrainian credits. Corporates in both countries are heavily distorted by the invasion. Despite financial profiles of Russian entities being generally strong, international sanctions increase settlement hurdles for many domestically focused corporates, and debt service ability has become highly unpredictable. Year-to-date, the corporate default rates of Russia and Ukraine are at 28% and 68%, respectively, and we expect the level to rise further for rest of 2022.
For the rest of CEEMEA, the region is dominated by issuers from the commodities sector, for which we have a positive outlook. Potential tail risk for corporates within the region could increase should their respective sovereigns come under stresses, for example, Ghana and Zambia. Thus far, no major CEEMEA sovereigns with active USD corporate bond markets show material default risk.
In Latin America, our default estimate of 2.5% is lower than the 10-year historical average of 4.9%. Our regional estimate takes into account tail risks in some non-bank financial institutions and companies in the Technology, Media and Telecom sector facing cash-flow pressures. A number of Argentine corporates have launched non-distressed exchanges preemptively in order to manage their USD debt in light of the country’s foreign exchange controls. Going forward, the maturity schedule of Argentine corporates is relatively light for the rest of 2022.
Looking into 2023, we expect the emerging market corporate high yield default rate to trend down to about 6%, based on our initial screening. This is a preliminary assessment, which is likely to change if some expected defaults from Russia and China property in 2022 are realized in 2023 instead. Still, around 80% of the expected Asian and CEEMEA defaults in 2023 relate to China property and Russia, respectively. For the rest of the emerging markets corporate high yield universe, we observe several supportive factors, including the following: (1) Average high yield net leverage is at the lowest level for LatAm and CEEMEA since 2015 and 2016, respectively, whereas Asia’s average net leverage has remained stable despite the stresses in the China property sector; (2) profit margins remain relatively stable away from China property; and (3) corporate capital expenditures have fallen across regions since the pandemic started. These favorable factors are being undervaluedin our view, which could be supportive of emerging market corporates for a contained level of default rates into 2023.
Figure 6: Net Leverage
Source: Bank of America, as of December 2021.
Figure 7: Capital Expenditures: Last 12 Months/EBITDA %
Source: Bank of America, as of December 2021.
Conclusion
We continue to see attractive opportunities in the emerging market corporate high yield space on an absolute basis, with The CEMBI High Yield spread at 600bps or more, against our expectation of a relatively contained emerging markets corporate default rate of 2.5% in 2022, excluding China property, Russia and Ukraine corporates.
